Option trading in practice – Week 8 and 9

Dear Readers and Traders, in today’s article I will bring you the summary of gas trading on our trading account at Interactive Brokers. Today’s article, however, is not just about trading itself, but also about the ban of ETF trading for retail traders and resulting adjustments of our strategy.

Summary of the week

Last week we managed to achieve a profit in the portfolio since the natural gas price dropped down, reducing the overall loss to about -0.35%. We had a smaller break in reporting. This was mainly caused by two factors: a) There were no necessary interventions in trading, b) Change in the ETF trading under Interactive Brokers for retail traders, which forced us to think about how to trade further. Let us now pay special attention to the second factor.

European Retail Client and ETFs

At the moment, we understand the situation as follows: IB prohibited based on MIFID 2 for the European retail clients trading ETF without KID. Since we estimate that the share of European retail clients in trading ETFs is very negligible (volumes are mainly provided by professional traders – hedge funds, banks, mutual funds, market makers, HFT and US retail clients), we do not expect to have in the future positive turnaround. It is, of course, possible that in the near future ETFs will deliver their KIDs, but we cannot rely on it.

Interestingly, however, the options for these ETFs are still being traded as such, but according to our sources they are cash-settled, so they will not be potentially assigned to the underlying asset, but within the assignment there will be a cash arrangement for the difference between the close price and the strike price. Positive part of this fact is that if the time premium is very large, then we get it basically free of charge. The problem is that if the underlying asset (in our example, ETF: BOIL) grows sharply within the trading session (say 10%), the sold BOIL call option is assigned to the close and if the next morning before the opening BOIL again drops (let’s say 10% again), we will close with the loss of 10% because we are no longer participating in the subsequent decline (our money were aligned but we are not assigned to short).

The question, of course, is whether our resources are right. To be sure, we’ve now set GTC commands for next week on UNG with weekly expiration where we will try to open options that are likely to be assigned. It is the best way to see how the Interactive Brokers will deal with the assignment, whether it will be really cash-settled or assigned to shares. However, it is still necessary to keep in mind that the situation may change in the future and the broker may introduce new or other rules.

Adjusting the strategy

If we would like to perform the safest way of trading and shorting natural gas, then it is necessary to wait throughout the year for the ideal entry point where the gas price is both fundamentally and technically at extremely high levels and then open the BEAR PUT spread, because in this option construction, there is virtually no assignment. Then we would gradually close the bear put spread positions and realize profits within the year.

The second alternative, less safe, but potentially more profitable, is to stay in naked options, but wait for the time premium. For example, we now see the call option:

BOIL 27C (July 2018) the time value is 35 cents, or 1.3% of the strike value

BOIL 29C (July 2018) the time value is 103 cents, which is 3.5% of the strike value

BOIL 26C (August 2018) the time value is 50 cents, which is 1.9% of the strike value

Currently, we will manage the option which is most endangered by assignment, that is BOIL 27C (July 2018). Probably we will rollover it to August 28.

In order to slightly reduce the absolute delta of our portfolio and position ourselves against the further growth of BOIL, where there is potentially a higher risk of assignment, we have opened 2 KOLD 39C call options (July 2018) with a time premium of US $ 1.15. It is still true that we want to keep the portfolio structurally in the short BOIL, but with this adjustment we are reacting to the current situation with the broker. ETF: KOLD is inverse to ETF: BOIL and will drop when the price of gas will grow.